April, 2016

21

The buzzword blockchain has reached new heights in finance history. Not since the invention of double-entry accounting in the thirteenth century has a method of keeping up with things promised our world so much improvement.

However, the greatest advancements in blockchain technology are all based on the advantages derived from the public, ‘open’ type of blockchain, while most people in the professional finance world are looking for advancements in the private, ‘permissioned’ type of blockchain.

Defining a blockchain

A blockchain, at its simplest level, is just a corruption-resistant string of ledger entries shared over a network by multiple parties. Without defining it further, it can be difficult to imagine how useful one is; What exactly could it do now that we couldn’t do with database technology like SQL before? Not much, really, and it would also be much slower than a SQL database. All of the advantages derived from basic blockchain technology can be boiled down to only two benefits; corruption resistance and redundancy.

All blockchains have this basic list of pros and cons, but depending on how they are implemented, the benefits could easily be minimized. For instance, if you deploy too few nodes then your network won’t be very redundant afterall. The list of advantages and drawbacks grows from there when choosing to deploy either a public or private blockchain.

The advantages of public blockchains

Public blockchains, including Bitcoin, Ethereum,Hyperledger, and most altcoins, are built to be accessible by anyone with adequate technology, which has so far meant a computer and access to the internet.

Rippleis technically a public blockchain, but is an interesting standout because it is built with a public-based architecture but is privately controlled through centralized ownership of the underlying currency and closed-source software. Whatever gains it had through decentralization are mostly lost due to the closed nature, which can be used to harm the network at any time the owning company, Ripple Labs Inc., makes any changes themselves.

All data on public blockchains are public by default, although it is common to hide the actual identity of all associated participants on them like Bitcoin does. This openness comes with advantages that have never existed before, such as the ability to resist hacking or capital controls from oppressive regimes. They derive their security by their very “public-ness,” where every participant can see all account balances and the movement of all transactions. This method still feels odd to us since we’re so new to this approach to security, but in seven years of bitcoin’s existence, no one has found a way to overcome that security in a practical way. Unfortunately, the cost isn’t always worth the benefits. To arrange a network like this is to lower the bandwidth between parties. Less data will move more slowly around the network because it must be duplicated by all parties.

Meanwhile, private blockchains are secured by the ancient model of user rights and secrets that we’ve become so comfortable with ever since the first lock was invented. The fewer people who know about your database, the safer it is in this model. This can work great if you don’t plan on sharing it with many people, but throughout history, there have been countless examples of this approach to security failing. Keys can be designed to be very smart, but there is always a hacker out there who is smarter. (Or an inside guy who is sneakier.)

This goes not just for the contents of the blockchain, but the rules governing it, as well. The more private a blockchain is run, the more likely the rules governing the blockchain can be changed.

While simple user rights management secures private databases, cryptoeconomics, a mixture of cryptography and economic incentives, is the method that keeps public blockchains secure. Since different organizations and users have varying goals for their networks, it is unlikely for one method to prevail against the other. Both have their niche, although it is still common for their niches to be misunderstood, so the question of their value is the subject of ongoing debate.

Time will tell on security

The crux of the issue comes down to whether or not private blockchains can ever be made secure enough to use for large amounts of value. No hacker is going to bother to attack your blockchain if it’s only being used for bingo night at a retirement home. However, the moment the world finds out that your blockchain has millions of dollars worth of payments flowing across it, you’ve basically just launched the latest hackathon, complete with a multi-million dollar, winner-take-all grand prize.

It may seem that public blockchains have to prove themselves more than private chains do, but the bitcoin blockchain has been tested under incredible stress already. It is the only one well tested and secured against such hackery, with a seven-year history of being too strong for any hacker to defeat, despite the 6.7 Billion dollar potential payday for doing so. Permissioned blockchains simply cannot claim to be that well secured.

This is the reason that Paul Chou, the bitcoin adviser to the U.S. Commodities and Futures Trading Commission (CFTC), has very little good to say about non-bitcoin blockchains. “A lot of the proposals for using blockchain without bitcoin are extremely misguided,” Chou stated in an interview with the New York Business Journal. “Maybe incredibly misguided, and certainly not proven.” Chou is a former quant trader for Goldman Sachs and is now the CEO of LedgerX, a blockchain startup with a New York City office on Madison Avenue. He spends his days building what he hopes to be “the first federally regulated bitcoin options exchange and clearing house to list and clear fully-collateralized, physically-settled bitcoin options for the institutional market,” when he’s not downtown advising the CFTC about Bitcoin at their offices.

Bitcoin maximalism

This mindset, notably bullish on the long-term prospects of bitcoin, is very common with bitcoin’s early adopters and those who are attracted to bitcoin from an economics perspective. It’s called ‘Bitcoin maximalism,’ which is a term coined by Ethereum creator Vitalik Buterin. It holds that the bitcoin blockchain will ultimately be the only dominant, secure blockchain eventually, squeezing the others out, and eventually all other currencies as well.

This stance is based on both computer science and economics. In each, the concept known as the Network Effect is extremely powerful for the first mover in a new network or protocol, and it never fails to push out all competition. Whether the bitcoin maximalists are right about it applying to bitcoin or just being naïve will be revealed in time, but it is clear that public blockchains offer unique advantages that a private blockchain simply cannot.

Advantages unique to public blockchains

For instance, a public blockchain is a transparency engine. In Vitalik Buterin’s blog post ‘On Public and Private Blockchains’ written last August, he pointed out that public blockchains “protect the users of an application from the developers, establishing that there are certain things that even the developers of an application have no authority to do.” A good example of this is a user of a social network or some other membership site where the owner changing their rules could create hardship or loss to the users. Thankfully, every time facebook makes a policy change these days, they notify the public, and only the affected people flood away from the service. If they weren’t open and honest about their changes, however, users would do well to demand a public blockchain to base their rules on.

Buterin also mentions that when multiple organizations use the same blockchain, its growth benefits from the network effect. Not only will it gain in popularity and, therefore, usefulness from multiple organizations promoting it, but it can also cut operational costs. “If we have a domain name system on a blockchain, and a currency on the same blockchain,” Buterin explained, “then we can cut costs to near-zero with a smart contract.”

There are other, smaller advantages to public blockchains too, but one powerful argument against private blockchains sticks out. A presentation popularized by the most in-demand bitcoin speaker, Andreas Antonopoulos, makes a comparison between private blockchains and corporate intranets. In the following video, thoughtfully entitled “Bubble boy and the sewer rat,” (hint: Bitcoin is the rat, but that’s a good thing) Antonopoulos argues that private blockchains, in fact, do have use in the business world today, but they come with the same limitations that company intranets have, including the considerable security problems.

http://www.youtube.com/watch?v=810aKcfM__Q

The main takeaway is that permissioned blockchains create an environment where malware has an advantage, so security problems are constant and sometimes completely overcome your network. Antonopolous is in strong agreement with Chou that sharing value between different entities still needs a public blockchain, and today this means Bitcoin’s blockchain.

The advantages of private blockchains

Meanwhile, there are certainly advantages to private blockchains that shouldn’t be overlooked in certain situations. First of all, the transaction speed of a privately-run blockchain can be faster than any other blockchain solution, approaching even the speeds of a normal database that isn’t a blockchain. This is because there are few nodes all with high trust levels. No need for every node to verify a transaction, in fact, they’re all mostly trusted so there is no need to do all of the meticulous work.

Privacy is obviously more assured on a private blockchain, too. This makes the privacy policy for data on that blockchain exactly the same as if it was in another database; without having to deal with access permissions and do it all the old way but, at least, the data isn’t publicly available by anyone with a net connection.

Private blockchains can either have completely free or at least very inexpensive transactions. If one entity controls and processes all of the transactions, then they have no need to charge a fee for the work. However, even if the transaction processing is done by multiple entities, such as competing banks, for instance, the transaction fees can still be very small for the same reasons that they can be so fast; Complete agreement between nodes isn’t required, so fewer nodes need to do the work for any one transaction.

Lastly, and perhaps most importantly in the current environment of banks embracing private blockchains so readily, choosing a private blockchain can help protect their underlying product from disruption. Banks and governments have a vested interest in seeing their product, the national fiat currency that they trade, remain valuable. Since the best use of a public blockchain is to secure a new, non-national currency like bitcoin, it is a disruptive threat to their core profit stream or organization and should be avoided by those entities at all costs.

Private blockchains come made to order

There are already far more private blockchains deployed than anyone can keep track of, thanks to companies like Deloitte’s Rubix,Eris Industries, andAlphaPoint’s Streamcore, who all sell turnkey solutions for private blockchains directly to businesses. There’s also Microsoft, who has begun offering “Blockchain as a Service” (BaaS), or private blockchain nodes packaged up as ‘quickstart templates’within its cloud service Azure. Deployment of these blockchain nodes, both public and private, are extremely simple for Azure members to do, so testing a blockchain and throwing it away an hour later is now possible. Lastly, there is the desktop route, deploying a private blockchain on your desktop computer, even in a windows environment, with Multichain. It allows rapid design, deployment and operation of private blockchains to your custom specification.

However, large, institutionalized projects like R3 CEV’s upcoming Consortium blockchain, or SWIFT’s own solution, get all of the press and glory, despite not even being completed yet. If the bitcoin maximalists are wrong about Bitcoin becoming a global monetary standard, it is likely that one of these top-level banking consortiums using a private blockchain will dominate the future of mainstream finance.